I hope this title got your attention because frankly, it is one of the most important issues facing traders. Let me play out this scenario:
You are staring at your trading charts when suddenly; your trigger to enter the market appears. You lay on the standard 2% risk (account balance x 2% / stop in points or pips) and in the trade you go. While that trade is under way, a setup in another market appears and following your plan, you enter that trade as well. Also, you have some longer term plays in progress as well.
What have you forgotten?
Only the most important part of trading – money management.
Have you taken into account the total exposure of your account in the markets? How much of your account are you going to leave in open positions?
If you are trading spot forex for example, there is a correlation between many of the currency pairs. Some will argue that, in the end, all your plays relate to the USD in one way or another. If correlation exists, what does that say about your positions?
Take the EURUSD and the GBPUSD for example. Look at the two charts below and see what direction they are headed. I put on a 50 MA to make it easier to observe what is going on with price and where it is located.
Pretty much in the same direction you should be thinking. You can almost say that, for the most part, the even the relationship with the 50 MA for both is pretty much the same.
So, what does that mean?
While not tracking in a perfect 1:1 formation, they are pretty close. If you were long both pair and the trades did not work out, your max loss is 4%. Perhaps you managed to reduce risk but, in the end, it is almost safe to say you are betting on the weakness of the USD to fuel your trades. Taking that into account, is it aggressive trading to max out on both positions? Sure it is.
The SST (Seven Summits Trader) from Netpicks is powerful. With trade plans provided for you, the ability to trade multiple markets, the ability to “add on” to trades, grab market reversals, to cut risk quickly and to trail, you can easily increase your bottom line. With that power however, comes responsibility. You would not want to put a newly licensed driver in the seat of the Bugatti Veyron without ensuring they had some experience. It is very important they understood exactly what they have in front of them.
During your trading day, you will be confronted with all sorts of setups. One thing to keep in mind is your overall exposure to the markets. If, for example, you are long the EURUSD at 2% risk and perhaps the add on appears or even a trade in another market, have you at least taken some risk out of your initial trade? That can be either with a scale out or the moving of your stop. The point is, where are you in the overall risk % of your account. Is it easy to say “risk 2% on your trades”. It is entirely different to say “risk 2% on your trades with max market exposure of 8%”. Another calculation you can make is to use your risk % on your NET ASSET VALUE (balance +/- unrealized P&L). At least that way, you are taking into account open positions and the effect they are having on your overall balance. This is extremely important if you are “taking heat” in any of your trades. You may want to consider unrealized profit or loss. When factoring your total market exposure, also keep in mind any longer term plays you have open.
In the end, how you manage your account is entirely personal. Just know that to take advantage of a positive expectancy strategy, you have to be able to financially survive the losses. If you play loose with your exposure, a string of losses or a sudden market event can put you on the sidelines.